Question

Asset Type	Asset Amount	Liability	Liability Amount
Reserves		Checkable Deposits
Loans		Bank Capital

Assume the government of Smithville uses measures of monetary aggregates similar to those used by the United States. The central bank of Smithville imposes a required reserve ratio of 20 percent. For additional information, refer to the figures below:

Bank Deposits held at the central bank = $400 million

Currency and coin held by the public = $500 million

Currency and coin in bank vaults = $200 million

Checkable deposits held by the banks in Broncoville = $1.4 billion

Traveler’s checks = $20 million

With the above information in mind, answer the following questions:

A. What is the size of M1?

B. Are commercial banks in Smithville holding excess reserves? If so, how much?

C. Can the commercial banking system increase checkable deposits? If so, by how much?

Answer 1

Checkable bank deposits = $1.4 billion i.e $1400 million

A.

M1 = Currency held by the public + Checkable Bank deposits + Traveler's checks

     = $500 + $1400 + $20

     = $1920 million

B.

Excess Reserve = Actual Reserves - Required Reserves

Reserves = Cash in bank vaults + Bank deposits held at the central bank

               = $200 + $400

               = $600

Therfore, Actual reserves = $600

Required Reserves = Reserve requirement * Checkable deposits

                             = 20% * $1400

                             = $280 million

Excess Reserve = $600 - $280

                        = $320 million

C.

Yes, commercial banking system can increase checkable deposits by $1600 million

Excess reserve = $320 million

Therefore, increase checkable deposits by = $320 / reserve requirement

                                                              = $320 / 0.2

                                                              = $1600 million